WEEK 11: PAY FOR PERFORMANCE PLANS
Pay for Performance [P4P]
Plans that link pay to productivity, profitability, or some other measure of individual,
team or organizational performance
Signals a movement away from entitlement toward pay that varies with performance.
Also called variable pay plans
Accurate performance appraisal or measurable outcomes is a precondition for
effective pay-for-performance plans
These plans can have a positive impact on performance if they are designed well
Can be Individual, group or organization-wide plans and short-term or long-term
Why Variable Pay?
Potential talent shortage employers need tools to attract, motivate and retain their
Advantages for Employers:
o Motivate better employee performance
o Manage total compensation costs
o Align business and individual goals
Advantage for Employees:
o Performance are rewarded accordingly
Specific Pay-for-Performance Plans: Short Term
1. Merit pay
2. Lump-sum bonuses
3. Individual spot awards
4. Individual incentive plans
A merit pay system links increases in base pay to how highly employees are rated on a
Employee achievements are rewarded every year the employee remains on the job.
Merit pay is expensive.
Many argue it does not achieve the desired goal of improving employee and corporate
Merit pay does have a small, but significant, impact on performance.
Managing Merit Pay
Improve accuracy of performance ratings
Allocate enough money to truly reward performance
Make sure size of merit increase differentiates across performance levels
Requirements to Link Pay to Performance
Specify a continuum describing different levels from low to high on performance
measure Decide how much of a merit increase is given for different levels of performance
See Exhibit 11.2
A more complex guideline ties pay not only to performance but also to position in the pay
range See Exhibit 11.3
Designing Merit Guidelines
What should the poorest performer be paid as an increase?
How much should average performers be paid as an increase?
How much should the top performers be paid as an increase?
What should be the size of the percentage increase differential between different levels of
How to Create a Merit Pay Grid
Merit Grids Combine 3 Variables:
o Level of Performance
o Distribution of Employees Within Pay Ranges
o Merit Budget Increase Percentage
Lump Sum Bonuses
Used as a substitute for merit pay.
Based on performance and received as an end-of-year bonus. Not built into base pay.
Viewed as less of an entitlement than